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Chapter 14 - Capital Investment Decisions
1. Projects that do not affect the cash flows of other projects are called mutually exclusive projects.
a.
True
b.
False
2. The process of planning, setting goals and priorities, arranging financing, and using certain criteria to select long-term
assets is called capital investment decisions.
a.
True
b.
False
3. Projects that if accepted preclude the acceptance of all other competing projects are called mutually exclusive projects.
a.
True
b.
False
4. In capital investment decision making, it is usually assumed that managers should select projects that attempt to
maximize the wealth of the owners of the firm.
a.
True
b.
False
5. Taxes are important consideration in forecasting cash flows.
a.
True
b.
False
6. Before-tax cash flows must be forecasted and used in capital investment decision making.
a.
True
b.
False
7. The two major categories of capital investment decision models are independent and mutually exclusive.
a.
True
b.
False
8. In order to use the payback period model, the proposed investment must have even cash inflows.
a.
True
b.
False
9. If cash flows are uneven, the payback period assumes that the inflows during the last fraction of a year occur evenly.
a.
True
Chapter 14 - Capital Investment Decisions
b.
False
10. One way to use the payback period is to set a maximum payback period for all projects and to reject any project that
exceeds this level.
a.
True
b.
False
11. Sometimes firms require riskier projects to have longer payback periods.
a.
True
b.
False
12. Companies considering projects with shorter lives are interested in longer payback periods.
a.
True
b.
False
13. A disadvantage of the payback period is that it ignores a project's total profitability.
a.
True
b.
False
14. A disadvantage of the payback period is that it ignores the time value of money.
a.
True
b.
False
15. Only accounting rate of return ignores the time value of money.
a.
True
b.
False
16. The payback period considers the profitability of a project over its entire life span.
a.
True
b.
False
17. Two discounting models for capital investment decision making are net present value and internal rate of return.
a.
True
b.
False
Chapter 14 - Capital Investment Decisions
18. The difference between the present value of the cash inflows and outflows associated with a project is the internal rate
of return model.
a.
True
b.
False
19. The minimum acceptable rate of return for a project is the required rate of return.
a.
True
b.
False
20. In practice, managers often choose a discount rate that is higher than the cost of capital.
a.
True
b.
False
21. Suppose that the actual cost of capital is 10%, but the firm chooses a discount rate of 18%. Managers of that company
will be more likely to choose relatively short term investments.
a.
True
b.
False
22. If the net present value of an investment is zero, the investment earns less than the minimum required rate of return.
a.
True
b.
False
23. The interest rate that sets the present value of a project's cash inflows equal to the present value of the project's cost is
called the internal rate of return.
a.
True
b.
False
24. The internal rate of return is the least widely used of the capital investment techniques.
a.
True
b.
False
25. One drawback to the internal rate of return model is that cash inflows must occur evenly over the life of the
investment.
a.
True
b.
False
Chapter 14 - Capital Investment Decisions
26. The internal rate of return is the most widely used of the capital investment techniques.
a.
True
b.
False
27. A postaudit evaluates the overall outcome of the investment and proposes corrective action if needed.
a.
True
b.
False
28. In general, it is best if postaudits are done by company management, since they understand the actual operating
conditions.
a.
True
b.
False
29. A disadvantage of postaudits is that they are costly.
a.
True
b.
False
30. A postaudit is an analysis of a capital project before it is implemented.
a.
True
b.
False
31. A key element in the capital investment process is called a postaudit.
a.
True
b.
False
32. Companies that perform postaudits of capital projects experience a number of benefits.
a.
True
b.
False
33. Postaudits ensure that resources are used wisely by evaluating profitability.
a.
True
b.
False
Chapter 14 - Capital Investment Decisions
34. Because of the postaudit, managers are more likely to make capital investment decisions in the best interests of the
firm.
a.
True
b.
False
35. Postaudits supply feedback to managers that should help improve future decision making.
a.
True
b.
False
36. Less objective results are obtainable if an independent party performs the postaudit of a capital investment.
a.
True
b.
False
37. The internal audit staff is usually the best choice for performing a postaudit of a capital investment.
a.
True
b.
False
38. An obvious problem with postaudits is that the assumptions driving the original analysis may often be invalidated by
changes in the actual operating environment.
a.
True
b.
False
39. Net present value analysis and internal rate of return analysis can sometimes produce erroneous choices because they
ignore the time value of money.
a.
True
b.
False
40. For independent projects, net present value analysis and internal rate of return analysis yield the same decision.
a.
True
b.
False
Chapter 14 - Capital Investment Decisions
41. The internal rate of return model does not consistently result in choices that maximize firm wealth.
a.
True
b.
False
42. _______________________ are concerned with the process of planning, setting goals and priorities, arranging
financing, and using certain criteria to select long-term assets.
43. The process of making capital investment decisions often is referred to as ________________.
44. The two types of capital budgeting projects are ________________ and _______________.
45. ______________________ are projects that, if accepted or rejected, do not affect the cash flows of other projects.
46. _____________________ explicitly consider the time value of money.
47. _______________________ ignore the time value of money.
48. The ______________ is the time required for a firm to recover its original investment.
49. The _________________________ measures the return on a project in terms of income.
ARR
50. _______________________ are the future cash flows expressed in terms of their present value.
51. The difference between the present value of the cash inflows and the outflows associated with a project is known as
the ___________________.
52. The ___________________ is the minimum acceptable rate of return.
53. The _______________________ is defined as the interest rate that sets the present value of a project’s cash inflows
equal to the present value of the project’s cost.
Chapter 14 - Capital Investment Decisions
(IRR)
IRR
54. If the internal rate of return (IRR) is greater than the required rate, the project is deemed ___________.
55. If the internal rate of return (IRR) is less than the required rate of return, the project is __________.
56. A key element in the capital investment process is a follow-up analysis of a capital project once it is implemented; this
analysis is a called a _____________.
57. The major disadvantage of a postaudit is that it is ____________.
58. When choosing among competing projects, the ___________________ model correctly identifies the best investment
alternative.
59. When choosing among competing alternatives the ________________ model may choose an inferior project in terms
of maximizing firm wealth.
IRR
60. The amount that must be invested now to produce a future value is known as the ____________ of the future amount.
61. The value of an investment at the end of its life is called its ________________.
62. In general terms, a sound capital investment will earn
a.
back its original capital outlay.
b.
a return greater than existing capital investments.
c.
back its original capital outlay and provide a reasonable return on the original investment.
d.
back its original capital outlay by the midpoint of its useful life.
e.
None of these.
63. To make a capital investment decision, a manager must estimate the
a.
quantity of cash flows.
b.
timing of cash flows.
c.
risk of the investment.
d.
impact of the investment on the firm's profitability.
e.
All of these.
Chapter 14 - Capital Investment Decisions
64. Which of the following is true of capital investment decision making?
a.
It is used only for independent projects.
b.
It is used only for mutually exclusive projects.
c.
It requires that funding for a project must come from sources with the same opportunity cost of funds.
d.
It is used to determine whether or not a firm should accept a special order.
e.
None of these.
65. If the cash flows of a project are received evenly over the life of the project, the formula for the calculating the
payback period is
a.
original investment / annual cash flow.
b.
original investment × annual cash flow.
c.
original investment + annual cash flow.
d.
original investment − annual cash flow.
e.
(original investment + annual cash flow) / annual cash flow.
66. The payback period provides information to managers that can be used to help
a.
control the risks associated with the uncertainty of future cash flows.
b.
minimize the impact of an investment on a firm's liquidity problems.
c.
control the risk of obsolescence.
d.
control the effect of the investment on performance measures.
e.
All of these.
67. Which of the following is a drawback of the payback period?
a.
It ignores a project's total profitability.
b.
It uses a set discount rate.
c.
It considers total profitability, requiring the forecasting of all future cash flows.
d.
It uses before-tax cash flows rather than after-tax cash flows.
e.
It uses operating income rather than cash flows.
68. A formula for the accounting rate of return is
a.
average income / initial investment.
b.
initial investment / annual cash flow.
c.
annual cash flow / initial investment.
d.
initial investment / average income.
e.
(average income + initial investment) / initial investment.
69. Managers may use the accounting rate of return to evaluate potential investment projects because
a.
debt contracts require that a firm maintain certain ratios that are affected by income and long-term asset levels.
b.
it serves as a screening measure to insure that new investments do not affect key financial ratios.
c.
bonuses to managers may be based on accounting income and/or return on assets.
Chapter 14 - Capital Investment Decisions
d.
it can be tied to the manager's personal income.
e.
All of these.
70. The time required for a firm to recover its original investment is the
a.
internal rate of return.
b.
net present value.
c.
life of the project.
d.
accounting rate of return.
e.
payback period.
71. When the risk of obsolescence is high, managers will want
a.
a shorter payback period.
b.
a longer payback period.
c.
a payback period equal to the life of the investment.
d.
All of these.
e.
None of these.
72. One disadvantage of the payback period is that
a.
it is sometimes used as a crude measure of risk.
b.
managers may choose investments with quick payback periods to maximize short term criteria on which their
own bonuses, etc. may be based.
c.
it cannot be used for investments with unequal cash inflows.
d.
it cannot be used if the entire cost of the investment does not occur immediately.
e.
All of these.
73. A division manager was considering a project that required a significant initial investment. If accepted, the project
could have a negative impact on certain financial ratios that the firm was required to maintain to satisfy debt contracts. To
ensure that the ratios would not be adversely affected by the investment, the manager would use which of the following
capital investment models?
a.
payback period
b.
accounting rate of return
c.
net present value
d.
internal rate of return
e.
None of these.
74. Greg Moss has just invested $120,000 in a coffee shop. He expects to receive cash income of $15,000 a year. What is
the payback period?
a.
5 years
b.
7.7 years
c.
4.5 years
d.
6.5 years
Chapter 14 - Capital Investment Decisions
e.
8 years
75. Carol Harrison is considering an investment in a retail shopping mall. The initial investment is $400,000. She expects
to receive cash income of $80,000 a year. What is the payback period?
a.
4 year
b.
3.5 years
c.
5 years
d.
2.5 years
e.
6 years
76. Elena Wallace invested $150,000 in a project that pays her an even amount per year for 10 years. The payback period
is 6 years. What are Elena's yearly cash inflows from the project?
a.
$150,000
b.
$15,000
c.
$25,000
d.
$90,000
e.
Cannot be determined from this information.
77. Tessa Wilson invested in a project with a payback period of 6 years. The project brings $18,000 per year for a period
of 9 years. What was the initial investment?
a.
$108,000
b.
$107,500
c.
$162,000
d.
$240,000
e.
Cannot be determined from this information.
78. Neil Morrison has just invested $130,000 in a restaurant. He expects to receive income of $24,000 a year, and to have
the investment for 8 years. What is the accounting rate of return?
a.
5.60%
b.
18.46%
c.
14.52%
d.
12.41%
e.
4.50%
79. An investment of $5,000 provides an average net cash flows of $320 with zero salvage value. Depreciation is $35 per
year. The accounting rate of return using the original investment is
Chapter 14 - Capital Investment Decisions
a.
4.0%
b.
5.1%
c.
5.7%
d.
3.2%
e.
2.4%
80. Buster Evans is considering investing $20,000 in a project with the following annual cash revenues and expenses:
Cash
Cash
Revenues
Expenses
Year 1
$ 8,000
$ 8,000
Year 2
$12,000
$ 8,000
Year 3
$15,000
$ 9,000
Year 4
$20,000
$10,000
Year 5
$20,000
$10,000
Depreciation will be $4,000 per year.
What is the accounting rate of return on the investment?
a.
15%
b.
35%
c.
70%
d.
75%
e.
None of these.
81. Coriander Company is considering a project with an initial investment of $426,800 in new equipment that will yield
annual net cash flows of $80,000, and will be depreciated at $53,350 per year over its eight year life. What is the
accounting rate of return?
a.
320%
b.
18.74%
c.
6.24%
d.
31.27%
e.
50.0%
Chapter 14 - Capital Investment Decisions
82. When comparing the payback method and the accounting rate of return methods, which of the following is true?
Profitability
Time Value of Money
i
Ignored by both methods
Ignored by both methods
ii
Ignored by both methods
Used in accounting rate of return; ignored
by payback method
iii
Considered by accounting method, not by
payback
Ignored by both methods
iv
Considered by accounting method, not by
payback
Considered by both methods
a.
i
b.
ii
c.
iii
d.
iv
83. Oakland Shop is considering the purchase of a used printing press costing $9,600. The printing press would generate a
net cash inflow of $4,000 per year for three years. At the end of three years, the press would have no salvage value. The
company's cost of capital is 10%. The company uses straight-line depreciation with no mid-year convention.
What is the accounting rate of return on the original investment in the press to the nearest percent, assuming no taxes are
paid?
a.
41.67%
b.
8.33%
c.
75.00%
d.
10.00%
Figure 14-1.
A company is considering two projects.
Project I
Project II
Initial investment
$120,000
$120,000
Cash inflow Year 1
$40,000
$20,000
Cash inflow Year 2
$40,000
$20,000
Cash inflow Year 3
$40,000
$32,000
Cash inflow Year 4
$40,000
$48,000
Cash inflow Year 5
$40,000
$50,000
84. Refer to Figure 14-1. What is the payback period for Project I?
a.
1 year
b.
3 years
c.
2.5 years
d.
3.5 years
e.
5 years
Chapter 14 - Capital Investment Decisions
85. Refer to Figure 14-1. What is the payback period for Project II?
a.
1 year
b.
2 years
c.
3.5 years
d.
4 years
e.
5 years
Figure 14-2.
A company is considering two projects.
Project A
Project B
Initial investment
$200,000
$200,000
Cash inflow Year 1
$50,000
$90,000
Cash inflow Year 2
$50,000
$90,000
Cash inflow Year 3
$50,000
$40,000
Cash inflow Year 4
$50,000
$30,000
Cash inflow Year 5
$50,000
$30,000
86. Refer to Figure 14-2. What is the payback period for Project A?
a.
4.5 year
b.
2.5 years
c.
5 years
d.
3.5 years
e.
4 years
87. Refer to Figure 14-2. What is the payback period for Project B?
a.
2 years
b.
4.5 years
c.
3.5 years
d.
2.5 years
e.
3 years
Figure 14-3.
Davis Company is considering the purchase of a new piece of equipment that will cost $1,600,000 and have a life of five
years with no expected salvage value. The expected cash flows associated with the project are as follows:
Cash
Cash Expenses &
Year
Revenues
Depreciation
Chapter 14 - Capital Investment Decisions
1
$1,500,000
$900,000
2
$1,500,000
$900,000
3
$1,500,000
$900,000
4
$1,500,000
$900,000
5
$1,500,000
$900,000
88. Refer to Figure 14-3. What is the average annual income for this project?
a.
$900,000
b.
$1,500,000
c.
$600,000
d.
$700,000
e.
$300,000
89. Refer to Figure 14-3. What is the accounting rate of return for the project?
a.
83.33%
b.
31.25%
c.
47.00%
d.
37.50%
e.
43.75%
Figure 14-4.
Sony Lavery is considering investing $45,000 in a project with the following cash revenues and expenses:
Cash
Expenses &
Year
Revenues
Depreciation
Year 1
$18,000
$8,000
Year 2
$22,000
$10,000
Year 3
$22,000
$9,000
Year 4
$24,000
$9,000
Year 5
$26,000
$9,000
Year 6
$28,000
$12,000
Year 7
$28,000
$11,000
Year 8
$28,000
$12,000
90. Refer to Figure 14-4. What is the average income for the project?
a.
$19,250
b.
$30,000
c.
$20,000
d.
$14,500
e.
$18,000
Chapter 14 - Capital Investment Decisions
91. Refer to Figure 14-4. What is the accounting rate of return for the project?
a.
32%
b.
41%
c.
20%
d.
26%
e.
35%
92. Refer to Figure 14-4. Assuming straight-line depreciation over 8 years, what is the payback period for the project?
a.
between 4 and 5 years
b.
between 2 and 3 years
c.
between 5 and 6 years
d.
between 7 and 8 years
e.
between 6 and 7 years
Figure 14-5.
Sara Turner is considering investing $60,000 in a project with the following cash revenues and expenses:
Cash Expenses &
Year
Revenues
Depreciation
Year 1
$16,000
$16,000
Year 2
$18,000
$16,000
Year 3
$17,000
$17,000
Year 4
$26,000
$14,000
Year 5
$26,000
$14,000
93. Refer to Figure 14-5. Assuming straight-line depreciation over five years, what is the payback period for this
investment?
a.
between 3 and 4 years
b.
between 2 and 3 years
c.
between 3 and 4 years
Chapter 14 - Capital Investment Decisions
d.
between 4 and 5 years
e.
between 1 and 2 years
94. Refer to Figure 14-5. What is the accounting rate of return for the project?
a.
8.67%
b.
15.60%
c.
7.50%
d.
3.10%
e.
Cannot be calculated with this information.
Figure 14-7.
Osler Company is considering an investment with the following data:
Initial cost
$200,000
Annual net cash inflows
$25,000
Expected life
10 years
Salvage value
none
Depreciation will be taken on a straight-line basis over the expected life of the investment.
95. Refer to Figure 14-7. What is the accounting rate of return for the investment?
a.
10%
b.
12.5%
c.
25%
d.
2.5%
e.
20%
Chapter 14 - Capital Investment Decisions
96. Refer to Figure 14-7. The company requires a minimum rate of return of 4%. What is the net present value of the
investment?
Period
1
2
3
4
5
6
7
8
9
10
4%
0.962
1.886
2.775
3.630
4.452
5.242
6.002
6.773
7.435
8.111
a.
$2,775
b.
$202,775
c.
$118,170
d.
($81,830)
97. Which of the following provides an absolute dollar measure?
a.
internal rate of return
b.
net present value
c.
payback period
d.
accounting rate of return
e.
None of these.
98. The required rate of return used in the net present value model can also be called the
a.
hurdle rate.
b.
minimum acceptable rate of return.
c.
cost of capital.
d.
discount rate.
e.
All of these.
99. If net present value is negative, it means that the return on the investment is
a.
less than the discount rate.
b.
more than the discount rate.
c.
equal to the discount rate.
d.
acceptable.
e.
meaningless since the return on the investment bears no relationship to the discount rate.
100. A division manager is considering a project that requires a significant initial investment. The company's top
management will not approve any project that does not return at least 12%. The manager will most likely use which of the
following capital investment models?
a.
payback period
b.
accounting rate of return
c.
net present value
Chapter 14 - Capital Investment Decisions
d.
internal rate of return
e.
None of these.
101. A firm is evaluating a project that has a net present value of $0 when a discount rate of 8% is used. A discount rate of
6% will result in a
a.
negative net present value.
b.
positive net present value.
c.
net present value of $0.
d.
The question cannot be answered based upon the information provided.
102. Jackson Company invests in a new piece of equipment costing $40,000. The equipment is expected to yield the
following amounts per year for the equipment's four-year useful life:
Cash revenues
$ 60,000
Cash expenses
(32,000)
Depreciation expenses (straight-line)
(10,000)
Income provided from equipment
$ 18,000
Cost of capital
14%
What is the net present value of this investment in equipment?
a.
$81,592
b.
$41,592
c.
$(4,480)
d.
$52,452
103. The following information pertains to an investment:
Investment
$140,000
Annual revenues
$96,000
Annual variable costs
$32,000
Annual fixed out-of-pocket costs
$20,000
Discount rate
12%
Expected life of project
8 years
The present value of the annual cash flow (rounded) is
a.
$136,822.
b.
$152,538.
c.
$204,884.
d.
$218,592.
Chapter 14 - Capital Investment Decisions
104. A firm is considering a project with an annual cash flow of $200,000. The project would have a seven year life, and
the company uses a discount rate of 10%. What is the maximum amount the company could invest in the project and have
the project still be acceptable?
a.
$718,200
b.
$1,400,000
c.
$973,600
d.
$200,000
105. A firm is considering a project with an annual cash flow of $80,000. The project would have a 10-year life, and the
company uses a discount rate of 8%. What is the maximum amount the company could invest in the project and have the
project still be acceptable (rounded)?
a.
$800,000
b.
$536,800
c.
$406,420
d.
$727,208
Figure 14-6.
Present value of $1
Periods
4%
6%
8%
10%
12%
14%
1
0.962
0.943
0.926
0.909
0.893
0.877
2
0.925
0.890
0.857
0.826
0.797
0.769
3
0.889
0.840
0.794
0.751
0.712
0.675
4
0.855
0.792
0.735
0.683
0.636
0.592
5
0.822
0.747
0.681
0.621
0.567
0.519
6
0.790
0.705
0.630
0.564
0.507
0.456
7
0.760
0.665
0.583
0.513
0.452
0.400
8
0.731
0.627
0.540
0.467
0.404
0.351
9
0.703
0.592
0.500
0.424
0.361
0.308
10
0.676
0.558
0.463
0.386
0.322
0.270
Present value of an Annuity of $1
Periods
4%
6%
8%
10%
12%
14%
1
0.962
0.943
0.926
0.909
0.893
0.877
2
1.886
1.833
1.783
1.736
1.690
1.647
3
2.775
2.673
2.577
2.487
2.402
2.322
4
3.630
3.465
3.312
3.170
3.037
2.914
5
4.452
4.212
3.993
3.791
3.605
3.433
6
5.242
4.917
4.623
4.355
4.111
3.889
7
6.002
5.582
5.206
4.868
4.564
4.288
8
6.733
6.210
5.747
5.335
4.968
4.639
Chapter 14 - Capital Investment Decisions
9
7.435
6.802
6.247
5.759
5.328
4.946
10
8.111
7.360
6.710
6.145
5.650
5.216
106. Refer to Figure 14-6. Morgan Clinical Practice is considering an investment in new imaging equipment that will cost
$400,000. The equipment is expected to yield cash inflows of $80,000 per year for a six year period. Morgan set a
required rate of return at 10%. What is the net present value of the investment? (Note: there may be a rounding error
depending on the table you use to compute your answer. Choose the answer closest to the one you calculate.)
a.
$51,600
b.
($51,600)
c.
$348,400
d.
($348,600)
e.
$451,600
107. Refer to Figure 14-6. Morgan Clinical Practice is considering an investment in new imaging equipment that will cost
$400,000. The equipment is expected to yield cash inflows of $80,000 per year for a six year period. At the end of the
sixth year, the firm expects to recover $150,000 from the sale of the equipment. Morgan set a required rate of return at
10%. What is the net present value of the investment? (Note: there may be a rounding error depending on the table you
use to compute your answer. Choose the answer closest to the one you calculate.)
a.
($33,000)
b.
$45,200
c.
$433,000
d.
$33,000
e.
($177,280)
108. Refer to Figure 14-6. Roman Knoze is considering two investments. Each will cost $20,000 initially. Project 1 will
return annual cash flows of $10,000 in each of three years. Project 2 will return $5,000 in year 1, $10,000 in year 2, and
$15,000 in year 3. Roman requires a minimum rate of return of 10%. What is the net present value of Project 1? (Note:
there may be a rounding error depending on the table you use to compute your answer. Choose the answer closest to the
one you calculate.)
a.
$20,000
b.
$25,670
c.
$4,860
d.
$22,530
e.
$2,530
